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External Analysis
Chapter 2 & 3
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Slide 2.2
Layers of the business environment
Johnson, Whittington and Scholes, Exploring Strategy, 9th Edition, © Pearson Education Limited 2011
The PESTEL Framework
• External environment consists of all the factors that can affect
the organization’s potential to gain and sustain a competitive
advantage.
• Why we do External Analysis
• Source and Proximity of External Environment (EE)
– The General Environment
• Little or no influence
– The Task Environment
• Some influence such as industry structure and strategic
groups
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The PESTEL Framework:
• The PESTEL model provides a
relatively straight forward way to
scan, monitor and evaluate the
important external factors.
• Remember, that with more open
markets and international trade, the
PESTEL have become more global
– E.g., Oil prices increase - Russia
– Ukraine conflict
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Political Factors
• Political factors result from the processes and actions of
government bodies that can influence the decisions and
behaviour of firms.
• Managers have almost little or no influence however,
– Cos try to influence it via lobbying, public relations,
contributions, litigation and so on….
– E.g., Uber ban
– https://fortune.com/2019/11/27/uber-london-ban-global-
ride-hailing-backlash/
• Political and legal factors are closely related
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Political Factors (Cont’d)
• The role of the state e.g., as an owner,
customer or supplier of businesses (State
involvement).
• Government policies. (Political Exposure)
• Taxation changes.
• Foreign trade regulations.
• Political risk in foreign markets.
• Changes in trade blocks (e.g., BREXIT).
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Economic Factors
• Mostly macro-economic affecting economy-wide
phenomenon
• Following 5 factors are the most important
– Growth rates
– Level of employment
– Interest rates
– Price stability (inflation)
– Currency exchange rates
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Socio-Cultural Factors
• Sociocultural factors capture a society’s
cultures, norms, and values.
• Evolving
• Strategic leaders need to closely monitor
such trends and consider the implications
for firm strategy.
– E.g. Health conscious customers,
setting trend, Subway
• Demographic trends are also important
sociocultural factors.
• These trends capture population
characteristics related to age, gender,
family size, ethnicity, sexual orientation,
religion, and socioeconomic class. Like
other sociocultural factors, demographic
trends present opportunities but can also
pose threats
– Urbanisation – leading to real estate
opportunities
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Technological Factors
• Technological factors capture the
application of knowledge to create new
processes and products.
– lean manufacturing, Six Sigma quality,
and biotechnology.
• How is the technology evolving and
affecting?
– Airbnb’s radical innovation, changing
the industry structure.
– Artificial Intelligence (AI) & LLM
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Ecological Factors
• Ecological factors involve broad
environmental issues such as the
natural environment, global
warming, and sustainable economic
growth.
• Organizations and the natural
environment coexist in an
interdependent relationship
• Think about: Water Shortage; Food
Security, Climate Change
• Managers can no longer separate
the natural and the business This Photo by Unknown Author is licensed under CC BY
• worlds; they are inextricably linked
• Negative Examples; BP’s oil spell
• Walmart opportunity in Disaster
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Slide 2.11
Legal Factors
• Legal factors include the official outcomes of political
processes as manifested in laws, mandates,
regulations, and court decisions—all of which can have
a direct bearing on a firm’s profit potential.
• In fact, regulatory changes tend to affect entire
industries at once.
• Deregulation over the past few decades, including
airlines, telecom, energy etc in several countries.
– Similarly in Pakistan
• Legal factors are partly due to political influences as
well
– Some of the examples; Uber in different
European countries
– Google
– Amazon in Germany
– Uber ban in Pakistan
– Autonomous cars
• Different legislations such as minimum wages,
harassment, equal opportunities, companies law,
contract law, corporate governance regulations
Johnson, Whittington and Scholes, Exploring Strategy, 9th Edition, © Pearson Education Limited 2011
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Legal factors (Cont’d)
Legal factors include:
• Labour, environmental and consumer regulations.
• Taxation and reporting requirements.
• Rules on ownership.
• Competition regulations.
• Regulation of corporate governance.
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Key drivers for change
Key drivers for change:
• Key drivers for change are environmental factors that are
likely to have a high impact on industries and sectors,
and impact on the success or failure of strategies within
them.
• Typically, key drivers vary by industry or market.
• For example, retailers are concerned with social changes
and customer behaviour which have driven a move to
‘out-of-town’ shopping. Personal disposable income also
drives demand for retailers.
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Using the PESTEL framework
• Apply selectively – identify specific factors which impact on the
industry, market and organisation in question.
• Identify factors which are important currently but also consider
which will become more important in the next few years.
• Use data to support the points and analyse trends using up-to-
date information (Strategic Analytics).
• Identify opportunities and threats – the main point of the
exercise.
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Forecasting
• All strategic decisions involve forecasts
about future conditions and
outcomes.
• PESTEL factors will feed into these
forecasts.
• Accurate forecasting is notoriously
difficult as organisations are
frequently trying to surprise their
competitors.
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Directions of change
• Megatrends
• Inflexion points
• Weak signals
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Scenarios
Scenarios are plausible views of how the
environment of an organisation might develop
in the future based on key drivers of change
about which there is a high level of uncertainty.
• Build on PESTEL analysis and drivers for
change.
• Offer more than a single view. An
organisation will typically develop a few
alternative scenarios (2–4) to explore and
evaluate future strategic options.
• Scenario analysis is used in industries with
long planning horizons, for example, the oil
industry or airlines industry.
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The Scenario Process
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Slide 2.19
Layers of the business environment
Figure 2.1 Layers of the business environment
Johnson, Whittington and Scholes, Exploring Strategy, 9th Edition, © Pearson Education Limited 2011
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Industries, markets and sectors
An industry is a group of firms producing products and
services that are essentially the same. For example,
the automobile industry and the airline industry.
A sector is a broad industry group (or a group of
markets) especially in the public sector (e.g. the health
sector).
A market is a group of customers for specific products
or services that are essentially the same (e.g. the
market for luxury cars in Germany).
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Competitive forces:
The five forces framework
Porter’s Five Forces Framework helps identify the
attractiveness of an industry in terms of five competitive
forces:
• The threat of entry.
• The threat of substitutes.
• The bargaining power of buyers.
• The bargaining power of suppliers and.
• The extent of rivalry between competitors.
The five forces constitute an industry’s ‘structure’.
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The five forces framework (1 of 6)
Source: Adapted from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter, copyright © 1980, 1998 by The Free Press.
All rights reserved.
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The five forces framework (2 of 6)
Rivalry between existing competitors
Competitive rivals are organisations with similar
products and services aimed at the same customer
group and are direct competitors in the same
industry/market (distinct from substitutes).
The degree of rivalry depends on:
• Competitor concentration and balance.
• Industry growth rate.
• High fixed costs.
• High exit barriers.
• Low differentiation.
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The five forces framework (3 of 6)
The threat of entry
Barriers to entry are the factors that need to be
overcome by new entrants if they are to
compete. The threat of entry is low when the
barriers to entry are high and vice versa.
The main barriers to entry are:
• Economies of scale/Experience/Network effects.
• Access to supply and distribution channels.
• Differentiation and market penetration costs.
• Legislation or government restrictions (e.g. licensing).
• Expected retaliation.
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The five forces framework (4 of 6)
The threat of substitutes
Substitutes are products or services that offer a similar benefit
to an industry’s products or services, but have a different nature
i.e. they are from outside the industry.
Customers will switch to alternatives (and thus the threat
increases) if:
• The price/performance ratio of the substitute is superior (e.g.
aluminium is more expensive than steel but it is more cost
efficient for car parts)
• The substitute benefits from an innovation that improves
customer satisfaction (e.g. high speed trains can be quicker
than airlines from city centre to city centre on short haul
routes).
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The five forces framework (5 of 6)
The bargaining power of buyers
Buyers are the organisation’s immediate customers, not
necessarily the ultimate consumers.
If buyers are powerful, then they can demand cheap prices or
product/service improvements to reduce profits.
Buyer power is likely to be high when:
• Buyers are concentrated.
• Buyers have low switching costs.
• Buyers can supply their own inputs (backward vertical integration).
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The five forces framework (6 of 6)
The bargaining power of suppliers
Suppliers are those who supply what organisations
need to produce the product or service. Powerful
suppliers can reduce an organisation’s profits.
Supplier power is likely to be high when:
• The suppliers are concentrated (few of them).
• Suppliers provide a specialist or rare input.
• Switching costs are high (it is disruptive or expensive to
change suppliers).
• Suppliers can integrate forwards (e.g. low-cost airlines have
cut out the use of travel agents).
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The Sixth Force: Complementors
Demand complementors:
An organisation is your complementor if it enhances
your business attractiveness to customers. (E.g. app
suppliers are complementors to smartphone
producers).
Supply complementors:
An organisation is a complementor with respect to
suppliers if it is more attractive for a supplier to deliver
when it also supplies the other organisation. (E.g. a
competing airline can be a complementor with respect
to a supplier like Boeing – as Boeing may invest more in
improvements if they are supplying both airlines).
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Implications of five forces analysis
• Which industries/markets to enter or leave? – it
helps identify the attractiveness of industries.
• What influence can be exerted? Identifies
strategies that can influence the impact of the five
forces. E.g. building barriers to entry by becoming
more vertically integrated.
• The forces may have a different impact on
different organisations. E.g. large firms can deal
with barriers to entry more easily than small firms.
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